France, Italy compare notes

November 20, 2013

French President Francois Hollande is in Rome for talk with Italy’s Enrico Letta. Both have a lot on their minds.

The French economy contracted in the third quarter and Hollande faces a blanket of criticism over his timid economic reforms (although he has pushed through some labour and pension changes).

The French government announced yesterday an overhaul of a complex tax system, hoping it will douse a public backlash against high taxes (which have been favoured over spending cuts so far) which has led to back-pedalling on several plans this year. It will not lower the overall tax burden but is promising a fairer system to be enshrined in the 2015 budget. Whether that does anything to revive its rock-bottom popularity rating remains to be seen. Detail is scant so far.

Several of the big institutional investors featured at the Reuters Investment Summit this week have been distinctly gloomy about France.

Letta seems finally to have seen off Silvio Berlusconi after the media mogul’s party split and half of it pledged to continue supporting the coalition government. But there is still plenty of disagreement about the 2014 budget, let alone the deeper structural reforms that Italy’s economy needs to lift it out of a decade-long malaise.

The two will hold a news conference. We’ll be watching for anything they might say about Germany’s reluctance to follow through on what was initially promised in terms of banking union and what they think the European Central Bank should do next.

Yesterday, the OECD joined the chorus urging the ECB to consider printing money to avoid a deflationary spiral. ECB chief economist Peter Praet said last week that outright asset-buying was possible and his colleague Vitor Constancio said “all those instruments are on the table” but that QE had not been discussed in any detail.

In reality, this would be hugely difficult for German policymakers and their allies to swallow. We know they opposed even this month’s far less dramatic quarter-point interest rate cut and, if anything, Praet backtracked a little yesterday, saying there was no sign of deflation in the euro zone.
If anything more is done, it is most likely to be a new round of long-term liquidity pumped into the banking system – a repeat of last year’s LTROs – which is what participants at the Reuters Investment Summit expect.

On banking union, Michel Barnier, the EU commissioner in charge of building a structure to prevent a future financial meltdown in the euro zone, is speaking to bankers at Euro Finance Week in Frankfurt. German Chancellor Angela Merkel may have something to say after meeting Norway’s new premier, Erna Solberg, in Berlin.

After downgrading France’s credit rating (while other agencies have upgraded the outlook for Portugal and Spain), Standard & Poor’s is holding a conference on European sovereign and bank ratings.

Minutes from the Bank of England’s last policy meeting might shed some further light on the British state of play. So far, the Bank’s forward guidance has sown nothing but confusion.

Having stated that it would not even think of raising interest rates until unemployment had dropped to 7 percent, or below, and predicting that would not happen before 2016, it has been forced to bring forward that forecast to late 2014. Yet the signal remains that rates are likely to stay at record lows for a lot longer.

A rapid economic upturn has upset the Bank’s thinking – which is obviously good news in the round – but it may have to simplify its message before long. UK rate-setters Spencer Dale and Martin Weale (a sceptic about forward guidance) are also speaking during the day.

For the markets, the big news is away from our region. Federal Reserve chief Ben Bernanke said yesterday that he was committed to ultra-loose policy for as long as needed while China set the yuan’s midpoint at its highest level since its 2005 revaluation, with its leaders signalling that currency reform could be speeded up giving markets more room to dictate the exchange rate.

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